If you wish to quickly understand market reactions to yesterday’s Congressional deal, you need only focus on three points: markets were delighted with the "what;" they are worried about the "how;" and the “how” matters going forward.
1. The "what" was extremely market friendly: By removing (for now) the immediate threat of a debt default and by re-opening the government, Congress clipped a material adverse "tail risk" to growth, jobs and financial stability -- and therefore to company earnings and funding prospects.
2. The "how" is less comforting: The deal reflected negative rather positive drivers. It involves neither a durable resolution nor a fundamental realignment of incentives. It simply kicks the can down the road; and to a time when the 2014 Congressional elections and primaries will seem a lot closer.
Think of the Congressional deal as the analytical equivalent of a short-dated ceasefire between (currently-exhausted) parties with deeply-conflicting views about the size and scope of government. As such, the probability of renewed political bickering is far from immaterial; and, as the President stated yesterday, there is a lot of work ahead for Congress.
3. The "how" matters: Neither endogenous growth nor the global economy are strong enough as yet to forcefully overcome political shenanigans. In addition, Congress needs to address other headwinds to growth and jobs. In the meantime, the economy and markets will remain over-dependent on a highly-activist Federal Reserve using experimental policy measures.
Instead of decisively emerging from a damaging phase of political dysfunction, Congress appears still stuck in what Game Theorists would call a repeated game with sub-optimal outcomes.
Only our lawmakers can change this situation for the better. The rest of us can help: By alerting them of the lasting damage to the economy, job creation and competitiveness; by cautioning them against undermining America’s standing in the global economy; and by encouraging them to durably improve economic and financial governance.
